HMRC Consultation Document on Profit Fragmentation: Unnecessary?
Brief summary of the consultation document
On 10 April 2018 HMRC issued a consultation document entitled ‘Tax Avoidance involving Profit Fragmentation’.
The proposed legislation which is the subject of the consultation is aimed at preventing UK traders and professionals from avoiding tax by arranging for their business profits to accrue to entities resident in territories where no tax or only a low rate of tax is paid. Such arrangements are said to usually be undertaken by small entities or individuals. It is anticipated that, subject to the consultation process, the proposed legislation will take effect from 6 April 2019.
In addition to targeted anti-avoidance, it will bring in a requirement for individuals to notify HMRC that they are entering into or have entered into the these types of structures.
The consultation document also introduces a potential requirement to pay the tax in dispute early. If, on review, HMRC has ‘a reason to believe ’that an amount is chargeable under the new rules, HMRC may issue a preliminary notice warning the individual of the reasons for the proposed charge. The individual will then have 30 days to submit submissions to HMRC. If HMRC remains unmoved by the submissions it will then issue a charging notice which will require the payment of tax which HMRC believes is due.
The UK tax system continues to move towards a presumption of guilt until innocence is proven (see also Accelerated Payment Notices and Partner Payment Notices, more on which below).
Who is the proposed legislation aimed at?
The consultation document provides examples of structures which are the target of HMRC’s proposed anti-avoidance legislation. In essence, HMRC are focussing on structures which move UK profits to an offshore entity in a low tax jurisdiction (usually a trust/corporate structure). One incarnation would have the offshore entity purporting to be offering a service (frequently framed as a ‘consultancy’ service) to a UK business. The UK business pays a fee for the offshore entity’s service, which in turn reduces the taxable profits of the UK business. The funds in the offshore entity eventually find their way back to the UK resident UBO of the UK business or a connected party.
HMRC provide other variants on this example, but the outcome is essentially the same, UK profits of a UK entity arising from a UK situs business are in part syphoned off to a low tax jurisdiction, and the UBO retains a power to enjoy.
Is this really necessary…?
I would argue that HMRC already has sufficient powers to tackle these types of avoidance structures under general anti-avoidance provisions.
Transfer of Assets Abroad
Immediately when I read the examples provided by HMRC I thought, ‘is this not already caught by the transfer of assets abroad (‘ToAA’) legislation (part 13 chapter 2 Income Tax Act (‘ITA’)2007)?’.
I do not want to get too bogged down in an analysis of the ToAA legislation, but if we just take a brief look and apply it to the example above, I will let you draw your own conclusion (plus, this is my idea of fun so humour me…).
The ToAA legislation, in essence, targets individuals who transfer income producing assets to a person abroad, when the transferor retains a ‘power to enjoy’ over those assets (i.e. she can still benefit from the income produced by the asset transferred). In this instance the income of the asset transferred is deemed to be that of the individual who transferred it and taxed accordingly.
Looking at the charge to tax that arises to a transferor of assets (‘the Transferor Charge’ – section 720 ITA 2007), the legislation requires the following:
Condition A - an individual has the power to enjoy income of a person abroad as a result of:
A relevant transfer;
One or more associated operations;
A relevant transfer and one or more associated operations;
Condition B – The income of the person abroad would be chargeable to income tax if it were received by the transferor in the UK.
Condition C – The individual is UK resident.
That seems simple enough. Applying the conditions to the above example (assuming the UK business is a business run as a sole trade by an individual, although the principle should still apply if the trade were run via a company), would the structure be caught by the ToAA?
S716 ITA 2007 defines ‘relevant transfer’ as a transfer of assets, as result of which (or one or more associated operations) income becomes payable to a person abroad. Additionally, and importantly, 716 (2) states ‘transfer’ in relation to rights includes the creation of rights’. s 717 defines ‘assets’ which includes ‘rights of any kind’.
A UK resident sole trader entering into a ‘consultancy agreement’ with an offshore company creates rights on both sides. The UK resident individual has a right to the services under the agreement and the offshore company has a right to be paid for those services. These rights have been created by the contract and consequently a relevant transfer has occurred as per s716 and s717 ITA 2007.
In short therefore we have a UK resident sole trader, entering into a consultancy agreement with an offshore company (the relevant transfer of assets to a person abroad). The UBO has a direct/indirect interest in the offshore company (she has a power to enjoy the income of the person abroad). Consequently, under the ToAA legislation, the UBO is taxed in the UK on income arising to the offshore company as a result of the relevant transfer as if it were hers. There is no motive defence available.
In this instance there appears no need for targeted anti-avoidance legislation as the structure is caught by general anti-avoidance legislation.
The General Anti-Abuse Rule (‘GAAR’)
Let us also not forget the GAAR (s206-215 FA 2013) which provides HMRC with significant powers to attack ‘tax arrangements that are abusive’.
Arrangements are ‘tax arrangements’ if, having regard to all the circumstances, it would be reasonable to conclude that the obtaining of a tax advantage was the main purpose, or one of the main purposes, of the arrangements.
Tax arrangements are abusive if they are arrangements ,the entering into or carrying out of which cannot reasonably be regarded as a reasonable course of action in relation to the relevant tax provisions (the famous double reasonableness test).
I would argue that the GAAR is a very powerful tool for HMRC to use against structures that it perceives as abusive. The GAAR was introduced in FA 2013 and took effect on 17 July 2013. It took until 18 July 2017 before the First Opinion Notices of the GAAR Advisory Panel were published. Why does HMRC simply not make better use of the GAAR?
In addition, if HMRC did use the GAAR (and a GAAR counteraction notice is given in relation to the asserted advantage), then by virtue of section 219 FA 2014, HMRC would be able to issue an Accelerated Payment Notice (or APN). An APN requires the recipient to pay the amount of tax that is in dispute within 90 days of the APN having been issued. This is to be treated as a payment on account of (what the legislation calls) the ‘understated’ tax. There is no right of appeal.
APNs are very powerful tools in HMRC’s armoury. If HMRC challenged the structures that the consultation document targets using the powers available under the GAAR, HMRC could also potentially issue APNs. There would then be no need for an additional power to demand early payment of tax.
To be fair to HMRC, it does acknowledge that ‘existing legislation can tackle many of these arrangements’. But it also says that
‘this legislation can be difficult to apply as it requires gathering large amounts of information, and the users and promoters of the arrangements may seek to delay matters by arguing that HMRC has no right to force the production of relevant information held offshore.’
HMRC, I should like to introduce you to schedule 36 FA 2008, which provides HMRC with very broad powers to request information. In fact, HMRC can ask for any relevant information that is within the person’s ‘possession or power’. If individuals do not comply then HMRC has powers to issue penalties (see part 7 of the said schedule 36).
Still, it is refreshing to see HMRC acknowledge that the ToAA legislation is difficult to apply…
The point I am trying to make is that the Government seems to want to introduce targeted anti-avoidance legislation when existing anti-avoidance legislation provides HMRC with enough power to tackle the targeted structures already. If used correctly, the GAAR also affords HMRC with the ability to demand early payment of the tax in dispute by issuing APNs. Much of what is proposed is already achievable in some form under existing general anti-avoidance provisions. If HMRC finds it too difficult to apply existing legislation, then amend and fix the current legislation rather implementing a whole new raft of unnecessary legislation!
I wonder if this is simply a question of Government wanting to appear to be attacking offshore structures in light of the Panama and Paradise Papers. In a period where the Government is doing a fine job of messing up our (wholly unnecessary and self-destructive) exit from the EU, it needs some vote winning policies – this I suspect is one.
I will leave you with this final thought. Under part 5 of the consultation document, next to the heading ‘Impact on businesses and Civil Society Organisations’, it says of the proposed legislation:
‘…It is likely to affect a small number of non-compliant businesses, estimated to be in the region of 4-5,000, which are currently involved in tax avoidance arrangements.’
In addition, with respect to Exchequer impact, it says
‘This measure is expected to increase receipts by approximately up to £50 million per annum.’
This begs the question, if HMRC already has the powers to go after these structures, as I think I have illustrated that it does, then why are they letting £50 million per annum escape tax and not using existing powers to do anything about it?